ECO 426 (Market Design) - Lecture 9
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1 ECO 426 (Market Design) - Lecture 9 Ettore Damiano November 30, 2015
2 Common Value Auction In a private value auction: the valuation of bidder i, v i, is independent of the other bidders value In a common value auction: bidders valuation are identical (i.e v 1 = v 2 = = v N = v) Examples Wallet auction Jar of pennies auction How much information each bidder has about the common value v matters Example: auctioning off a wallet with a SPA, how much would you bid if: Everybody gets to see the content of the wallet Just one person does Nobody does
3 Private Information in common value auction Interesting case is when each bidder has some private information about the common value of the object for sale Example: Two bidders with common value v Bidder 1 observes s 1 = v + ɛ 1 Bidder 2 observes s 2 = v + ɛ 2 The two terms ɛ 1 and ɛ 2 are (independent) error terms s i is bidder i s private estimate of the common valuation second price auction If all information were observed the public estimate of the common valuation would be s 1 + s 2 2 = v + ɛ 1 + ɛ 2 2 Question: Should a bidder bid his private estimate of v?
4 Common Value Auction Bidding own estimate not longer a dominant strategy. price paid when winning never larger than own estimate of v winning is bad news the winner was more optimistic about v than his opponents knowing your opponents have a lower estimate of v that you do decreases your estimate of v winning the object reduces how much you think it is worth winner s curse similarly, losing the auction may increase how much you think it is worth loser s curse equilibrium bidding must reflect the information contained in the event you are winning
5 Bidding in a common value second price auction Claim: In the equilibrium of the second price auction, bidders use the strategy b(s i ) = E[v s i, s j = s i ] bidders bid an estimate of v obtained: i) using their private information; and ii) assuming their opponent observes exactly the same signal. estimate v assuming a tie when winning Sketch of the argument In equilibrium bidders cannot gain from marginally lowering or increasing their bid (i.e. bidding b(s) + ɛ or bidding b(s) ɛ) Marginal changes in a bid only matter if there is a tie (i.e. if my opponent has my same signal) If b(s i ) < E[v s i, s j = s i ], can gain by marginally raising bid If b(s i ) > E[v s i, s j = s i ], can gain by marginally lowering bid
6 Common value auction winner s and loser s curse Do bidders bid more or less than their private estimate of v in equilibrium? Example 1: Second price auction, 1 object for sale, N > 2 bidders Equilibrium bidding strategy b(s) = E[v s is tied for highest estimate] < E[v s] winner s curse Example 2: Lowest price auction, N 1 objects for sale, N > 2 bidders Equilibrium bidding strategy b(s) = E[v s is tied for lowest estimate] > E[v s] loser s curse
7 Revenue comparison Revenue equivalence no longer holds Expected revenue comparison Ascending price > Second Price > First price Milgrom-Weber: an open auction does better than a sealed bid auction with correlated estimates of a common value Broader result: Linkage principle Suppose the seller can give bidders access to better information. Then the revenue is increased on average by making the information publicly available public information will move everyone s bid in the same direction (i.e. up if good news, down if bad news) public info will on average be good news when the high bidder has high value, reducing the winner s profit when it is high
8 Examples of common value auctions. Treasury bill auctions common value is resale price in the secondary market Natural resources Timber auctions: quality and type of timber available in the tract auctioned off is uncertain Oil Lease auction quantity of oil available in the tract auction off is unknown bidders do independent seismic studies - private information on the amount of oil reserves in the tract
9 Outer continental shelf auctions The US Government auctions off the right to drill for oil on the outer continental shelf
10 Outer continental shelf auctions No one knows how much oil there is in a tract being auctioned off Before the auction, bidders conduct seismic studies to obtain an estimate of the amount of oil available Seismic studies results are valuable private information, which bidders do not share with each other Two different type of tracts are auctioned off Wildcat sale : new territory being sold Drainage sale : territory adjacent to already developed tracts Question: What is different between these two types of sales?
11 Wildcat vs. Drainage drainage sales more profitable than wildcat sale (for the bidders)
12 Drainage sales closer look Drainage sales are only profitable to insiders Asymmetric information matters
13 Common value auctions with asymmetric information Common value v Two bidders Insider knows v Outsider believes that v is U[0, 1] Ascending price auction equilibrium? insider stays in until price hits v (dominant strategy) outsider drops immediately seller revenue = 0 First price auction equilibrium?
14 First price auction equilibrium Equilibrium properties Outsider cannot play a pure strategy, b o, in equilibrium If b o = 0, the insider s best response would be a small bid larger than 0, b i = ɛ. Not an equilibrium: the outsider can profitably deviate to a small bid b o = 2ɛ. If b o > 0, the insider s best response would be to bid just above when b o < v and below it when b o > v Not an equilibrium: the outsider only wins when b o > v, making negative profits
15 First price auction equilibrium Outsider randomizes across many bids loses for sure at lowest bid lowest bid must be zero wins for sure at highest bid, b expected payoff from each bid must be zero expected payoff from b is E[v win, b] b = 1 2 b b = 1 2 For each bid value, between 0 and 1/2, the indifference condition implies Prob(win b)(e[v win, b] b) = 0 E[v win, b] = b Winning means the insider s value is below a certain value, ṽ(b) (monotone strategies), hence E[v win, b] = ṽ(b)/2 the threshold value must be ṽ(b) = 2b the insider bidding strategy must be b i (v) = v/2
16 First price auction equilibrium The outsider randomizes among bids in the interval [0, 1] The probability that the outsider places a bid smaller than x is F (x) = 2x The insider plays a pure strategy The insider places a bid equals to half of his valuation b i (v) = v/2 The outsider strategy is a best response to b i (v) By construction, outsider is indifferent between any bid in [0,1/2] no need to bid more that 1/2 since at 1/2 wins for sure Consider an insider with valuation v, bidding b has an expected payoff Prob(win b)(v b) = 2b(v b), which is maximized at b = v/2
17 First price auction Comparing bids Both insider and outsider bids are distributed uniformly on the interval [0,1/2] It is equally likely that insider and outsiders win, but insider wins more often when v is high outsider wins more often when v is low given a valuation v the insider wins with probability v The distribution of information across bidders is crucial
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